Lo and behold, just as one month passes by after the economic survey, we have countries in the Middle East scurrying to war. As India watches by, it brings nothing but more friction to an already dull investment climate.

Stagnant Private Capex

Despite the government’s record breaking public capex estimated at 4.4% of GDP for FY27, private sector participation remains muted, it has been stagnant hovering around ~23% of total Gross Fixed Capital Formation (GFCF) for a long time. For emerging and developing economies like us which need to create more jobs to in turn drive consumption, this remains the missing engine.

Credit Cooling

Along with immediate Capex, companies also seem to be pulling away from creating capacity or projects in the near future, largely deleveraging and using idle cash for buybacks instead of creating IP assets. The share of industrial credit is declining while the share of unsecured personal credit is increasing in the economy. Banks have pivoted heavily toward retail loans (housing, personal loans) and the services sector. This shift reflects a cautious approach by both lenders and borrowers in the industrial segment.

The Global Retreat of FDI

While FPI in a country is less sticky and prone to flight, FDI is considered to be more sticky & unfortunately FDI in India has also not moved much in spite of recent interventions like PLI schemes and tax breaks offered heavily under Made In India. The beneficiary of China plus one strategy seem to be other countries in Asia notably Thailand and Vietnam while China is moves away from heavy machinery towards the new three sectors- Electric Vehicles, Lithium Batteries and Solar Products. South Korea has been moving forward in hardware required for AI infrastructure to be competitive against it’s peers in China and Taiwan.

The Unlikely Victims of Connected World Order

The unlikely victims of this interconnected world order seem to be far and wide. In countries elsewhere of Middle East- the tremors were felt in KOSPI index crash which is the Korean Stock Market index heavily influenced by Samsung and SK Hynix which manufacture RAM and power most of the AI infra that we see today and which was affected in response to Amazon Data Centers damaged in the war.

The other distant victim seems to be the sale of Indian Premium Spirits which have shown nearly flat sales growth even while the domestic market seems to flourish and preimmunize endlessly. While Indian travelers are increasing, a global downturn in discretionary spending at Western airports has stunted the international breakout of Indian luxury brands.

The Silver Lining

The prospects of continuous and ongoing proxy as well as real wars have prompted some companies to onshore even in the face of FTA’s being signed, because let’s face it, in this fragile world, nothing is permanent. The biggest bet that I read of in recent times seems to be the inauguration of the INR 9,000 Cr. Jaguar Land Rover plant in Tamil Nadu by Tata Motors which is betting big on the Indian Market.

Conclusion

The economy and the companies now have to move beyond operating efficiency towards optionality & trade offs. On-shoring, creating multiple sources and capacity plug ins will ultimately make it costlier for the consumer to buy all products in general. The increase in Oil prices with a war premium will surely cascade down to energy prices in EU and India further. The Indian economy’s era of low inflation and high growth rates will come into doubt, making it harder for the government to spend on Public Infrastructure as well as for RBI to support the already fragile rupee tumbling down against the dollar. May the guns fall silent, may we embark again on a journey of glorious peaceful growth.

This post is a short understanding of what part of equity and deposits the bank is able to lend out as loans and how different regulations reduce the available credit in the economy. This would be helpful to any one who is reading the financial statements of banks and trying to make sense of it.

Reserve Requirements

First we will look at capital requirements which Banks have to keep to function under duress (that is in event of a bank run). In India this is in the form of -

1. Cash Reserve Ratio (CRR) - Banks must maintain a certain percentage of Net Demand and Time Liabilities (NDTL) with RBI in cash. This portion earns no interest and cannot be used for lending. As of today the CRR is 4.00%.

2. Statutory Liquidity Ratio (SLR) - Banks need to maintain a certain percentage of NDTL in form of liquid assets like cash, gold and approved sovereign bonds. The amount held in sovereign bonds earns interest but is not available freely for lending. As of today SLR is 18.00%.

Equity Capital Requirements

The next form of capital which gets locked up for the bank is in the form of the Capital Adequacy Ratio (CAR) & Capital Conservation Buffer which is funds tied up for every 100 INR lent. CAR restricts the extent of lending relative to the banks capital base. This is part of the Basel forms put in force after the 2008 Financial crisis.

CAR consists of Tier 1 + Tier 2 capital →

1. Tier 1 Capital - Core capital of bank, which is strongest buffer against losses. Consists of Paid up Equity Capital, Statutory Reserves, Retained Earnings & instruments as per RBI guidelines Perpetual non-cumulative preference shares & perpetual debt instruments.

2. Tier 2 Capital - Secondary capital to absorb losses but is less permanent and lower in quality. Consists of Subordinated debt, General Provisions and Loan loss reserves.

CAR = [Tier 1 Capital + Tier 2 Capital / Risk Weighted Assets (RWAs)] *100

Different type of Assets or loans get different weights as per the risk they carry and is also pre-decided by RBI.

• 0%: Cash, government securities.

• 50%: Housing loans (Loan To Value Ratio <= 75%).

• 75%: Housing loans (Loan To Value Ratio <= 75% and above Rs.30 lakh).

• 100%: Business loans, some NBFC loans (depending on rating), and some microfinance loans (depending on whether they are considered consumer credit).

• 125%: Unsecured retail loans, some microfinance loans (depending on whether they are considered consumer credit), and some NBFC loans (depending on rating).

• 150%: Some NBFC loans (depending on rating) and credit card receivables

CET 1 is a subset of Tier 1 capital and is of the highest quality which means it does not even include the perpetual shares and debt.

CET 1 Ratio = [CET 1 Capital / RWAs]*100

This forms a part of the total CAR.

Capital Conservation Buffer (CCB) -

As per RBI & Basel 3 norms, these are the required capital buffers →

The last but not the least is the Leverage Ratio which measures the bank’s core capital (Tier 1) against its total exposure without risk weighting.

Leverage Ratio = [Tier 1 Capital/ Total Exposure]*100

Total Exposure includes both on-balance sheet exposures- loans, investments and advances.

Off-balance exposures - Letters of credit, guarantees, derivatives exposure.

Under Basel 3- 3% globally while RBI generally requires ~4.5% for Indian Banks.

Liquidity Requirements

All the topics covered were the basics but there are some other liquidity requirements which are necessary for banks to maintain.

Liquidity Coverage Ratio (LCR) - It is a Basel 3 requirement which makes a bank to hold a sufficient stock of High Quality Liquid Assets (HQLAs) to cover net cash outflows for 30 days under a stressed scenario.

LCR = [Stock of High Quality Liquid Assets (HQLAs) / Total Net Cash Outflows over 30 days]*100

HQLAs can be easily and immediately converted into cash with little/no loss of value like Cash Balances with RBI, Govt. Securities.

Total Net Cash Outflows (30 days) = Expected Cash Outflows- Expected Cash Inflows

Outflows: Withdrawals of deposits, drawdowns of credit lines.

Inflows: Loan repayments, maturing investments (up to a cap of 75% of outflows).

Under Basel 3- Banks required to maintain LCR >=100%

Net Stable Funding Ratio (NSFR) - Requires banks to maintain stable funding profile in relation to the composition of their assets and off-balance sheet activities over one year horizon.

NSFR = [ (Available Stable Funding- ASF)/ (Required Stable Funding- RSF)]*100

Key Components of ASF - Funding sources expected to be reliable over the one-year horizon like Regulatory Capital (equity, Tier 1 and Tier 2 Capital), Long term deposits and long term borrowings with maturity greater than 1 year.

Key Components of RSF - Determined by liquidity characteristics & residual maturities of the bank’s assets and off balance sheet exposures. Assets are weighted according to their liquidity like Cash (0% weightage), Loan to retail customers (85% weightage) while Long term corporate loans (100% weightage).

NSFR should be >= 100% under Basel 3. This ensures banks have sufficient stable funding to support their long-term illiquid assets and activities.

Summary

To lend INR 100 →

Equity Requirement (Own Capital Required) - CAR+CCB - 11.5% of 100 = 11.50

Reserve Requirements (RBI) - Certain % of NDTL set aside- CRR + SLR - 4.5% + 18% = 22.5% of NDTL. To actually asses NDTL present with bank, we need to check the Credit to Deposit ratio which can be around 75% for healthy banks. So for lending 100, 133.33 would be required.

So reserve requirements = 22.5% of 133.33 = 30 INR

Further understanding can be built by reading the Annual Reports of Banks which disclose all the above requirements plus additional reserves banks keep for prudency and fiscal health.

I will also write more on the P&L of a bank and the provisions created by the bank and the history behind the large NPAs which used to pull our banks in the previous decade in the upcoming articles.